Above full-employment equilibrium A situation in which macroeconomic equilibrium occurs at a level of real GDP above long-run real GDP.

Absolute advantage A person has an absolute advantage in the production of two goods if by using the same quantities of inputs, that person can produce more of both goods than another person. A country has an absolute advantage if its output per unit of inputs of all goods is larger than that of another country.

Aggregate demand The relationship between the aggregate quantity of goods and services demanded (real GDP demanded) and the price level (the GDP deflator).

Aggregate hours The total number of hours worked by all the people employed, both full-time and part-time, during a year.

Aggregate planned expenditure The expenditure that economic agents (households, firms, governments and foreigners) plan to undertake in given circumstances.

Aggregate production function The relationship that shows how the maximum real GDP attainable varies as quantities of factors of production vary.

Allocative efficiency A situation that occurs when no resources are wasted – when no one can be made better off without someone else being made worse off. Allocative efficiency is also called Pareto efficiency.

Arc elasticity of demand The value of elasticity of demand between two points calculated by the average price method.

Automatic fiscal policy A change in fiscal policy that is triggered by the state of the economy.

Autonomous expenditure The sum of those components of aggregate planned expenditure that are not influenced by real GDP.

Average cost pricing rule A rule that sets price equal to average total cost.

Average fixed cost Total fixed cost per unit of output – total fixed cost divided by output.

Average product The average productivity of a factor of production – total product divided by the quantity of the factor employed.

Average revenue The revenue per unit of output sold – total revenue divided by the quantity sold. Average revenue also equals price.

Average total cost Total cost per unit of output.

Average variable cost Total variable cost per unit of output.

Balance of payments accounts A country’s record of international trading, borrowing and lending.

Balance of trade The value of exports minus the value of imports.

Balanced budget A government budget in which tax revenues and expenditures are equal.

Balanced budget multiplier The amount by which a simultaneous and equal change in goverment purchases and taxes is multiplied to determine the change in equilibrium expenditure.

Bank A private firm licensed by the Bank of England under the Banking Act of 1987 to take deposits and make loans and operate in the United Kingdom.

Bank of England The central bank of the United Kingdom.

Barriers to entry Legal or natural impediments protecting a firm from competition from potential new entrants.

Barter The direct exchange of one good or service for other goods and services.

Capture theory A theory of regulation that states that the regulations are supplied to satisfy the demand of producers to maximize producer surplus – to maximize economic profit.

Cartel A group of firms that has entered into a collusive agreement to restrict output so as to increase prices and profits.

Central bank A public authority charged with regulating and controlling a country’s monetary policy and financial institutions and markets.

Central plan A detailed economic blueprint that sets out what will be produced, how, when and where it will be produced, and who will get what is produced, and that establishes a set of sanctions and rewards designed to ensure that the plan is fulfilled as fully as possible.

Ceteris paribus Other things being equal – all other relevant things remaining the same.

Change in demand A change in buyers’ plans that occurs when some influence on those plans other than the price of the good changes. It is illustrated by a shift of the demand curve.

Change in supply A change in sellers’ plans that occurs when some influence on those plans other than the price of the good changes. It is illustrated by a shift of the supply curve.

Change in the quantity demanded A change in buyers’ plans that occurs when the price of a good changes but all other influences on buyers’ plans remain unchanged. It is illustrated by a movement along the demand curve.

Change in the quantity supplied A change in sellers’ plans that occurs when the price of a good changes but all other influences on sellers’ plans remain unchanged. It is illustrated by a movement along the supply curve.

Classical growth theory A theory of economic growth based on the view that population growth is determined by the level of income per person.

Coase theorem The proposition that if property rights exist and transactions costs are low, private transactions are efficient – equivalently, there are no externalities.

Collective bargaining A process of negotiation between representatives of employers and unions.

Collusive agreement An agreement between two (or more) producers to restrict output so as to increase prices and profits.

Commodity money A physical commodity that is valued in its own right and is also used as a means of payment.

Common Agricultural Policy (CAP) The agricultural policy implemented by the European Union in member countries.

Company A firm owned by two or more shareholders.

Comparative advantage A person or country has a comparative advantage in an activity if that person or country can perform the activity at a lower opportunity cost than anyone else or any other country.

Competition A situation where individuals and firms are forced into a contest for the command of scarce resources because of scarcity.

Complement A good that is used in conjunction with another good.

Constant returns to scale Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by the same percentage.

Consumer efficiency A situation that occurs when consumers cannot make themselves better off by reallocating their budgets.

Consumer equilibrium A situation in which a consumer has allocated his or her income in the way that maximizes his or her utility.

Consumer surplus The value that the consumer places on a good minus the price paid for it.

Consumption demand The relationship between consumption expenditure and the real interest rate, other things remaining the same.

Consumption expenditure The total payment made by households for consumption goods and services.

Consumption function The relationship between consumption expenditure and disposable income, other things remaining the same.

Contestable market A market structure in which there is one firm (or a small number of firms) and because of freedom of entry and exit, the firm (or firms) faces competition from potential entrants and so operates like a perfectly competitive firm.

Contractionary fiscal policy A decrease in government expenditures or an increase in tax revenues.

Convertible paper money A paper claim to a commodity (such as gold) that circulates as a means of payment.

Copyright A government-sanctioned exclusive right granted to the inventor of a good, service, or productive process to produce, use, and sell the invention for a given number of years.

Corporation A large-scale firm owned by shareholders whose liability is legally limited to the value of their initial investment.

Cost-push inflation Inflation that results from an initial increase in costs.

Creditor nation A country that has invested more in the rest of the world than other countries have invested in it.

Cross elasticity of demand The responsiveness of the demand for a good to the price of a substitute or complement, other things remaining the same. It is calculated as the percentage change in the quantity demanded of the good divided by the percentage change in the price of the substitute or complement.

Cross-section graph A graph that shows the values of an economic variable for different groups in a population at a point in time.

Crowding out The tendency for an increase in government purchases of goods and services to bring a decrease in investment.

Currency The notes and coins that we use today.

Currency depreciation The fall in the value of one currency in terms of another currency.

Currency drain An increase in currency held outside banks.

Current account A record of receipts from the sale of goods and services to foreigners, the payments for goods and services bought from foreigners, the interest income received from and paid to foreigners, and gifts and other transfers (such as foreign aid payments) received from and paid to foreigners.

Cyclical deficit A budget deficit that is present only because real GDP is less than potential GDP and taxes are temporarily low and transfer payments are temporarily high.

Cyclical unemployment The unemployment arising from the slowdown in the pace of economic expansion.

Cyclically adjusted deficit The budget deficit that would occur if the economy were at full employment.

Deadweight loss A measure of allocative inefficiency. It is equal to the loss in total surplus (consumer surplus plus producer surplus) that results from producing less than the efficient level of output.

Debtor nation A country that during its entire history has borrowed more from the rest of the world than it has lent to it.

Decentralized planning An economic system that combines state ownership of capital and land with incentives based on a mixture of market prices and laws and regulations.

Decreasing returns to scale Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a smaller percentage.

Demand The relationship between the quantity of a good that consumers plan to buy and the price of the good, with all other influences on buyers’ plans remaining the same. It is described by a demand schedule and illustrated by a demand curve.

Demand curve A curve that shows the relationship between the quantity demanded of a good and its price, all other influences on consumers’ planned purchases remaining the same.

Demand-pull inflation Inflation that results from an initial increase in aggregate demand.

Deposit money Deposits at banks and other financial institutions; an accounting entry in an electronic database in the banks’ and other financial institutions’ computers.

Deposit multiplier The amount by which an increase in bank reserves is multiplied to calculate the increase in bank deposits.

Depreciation The decrease in the value of capital stock or the value of a durable input that results from wear and tear and the passage of time.

Deregulation The removal of regulatory rules to restrict or control economic activity in price setting, product standards, trading standards and the conditions under which firms can enter an industry.

Derived demand Demand for an item not for its own sake but for use in the production of goods and services.

Desired reserve ratio Ratio of reserves to deposits that banks consider as prudent to hold in order to meet withdrawals and to carry on their business.

Diminishing marginal rate of substitution
The general tendency for the marginal rate of substitution of one good for another to diminish as a consumer increases consumption of the first good.

Diminishing marginal returns The tendency for the marginal product of a variable factor eventually to diminish as additional units of the variable factor are employed.

Diminishing marginal utility The marginal utility that a consumer gets from a good decreases as more of the good is consumed.

Direct relationship A relationship between two variables that move in the same direction.

Discount rate The interest rate at which the central bank stands ready to lend reserves to commercial banks.

Discounting The conversion of a future amount of money to its present value.

Discouraged workers People who do not have jobs and would like to work but have stopped seeking work.

Discretionary fiscal policy A policy action that is initiated by the Chancellor of the Exchequer.

Discretionary policy A policy that responds to the state of the economy in a possibly unique way that uses all the information available, including perceived lessons from past ‘mistakes’.

Discrimination Occurs in the labour market when employment decisions are taken on the basis of ethnic origin or gender rather than ability.

Diseconomies of scale Technological conditions under which long-run average cost increases as output increases.

Dominant strategy equilibrium The outcome of a game in which there is a single best strategy (a dominant strategy) for each player, regardless of the strategy of the other players.

Dumping The sale of a good in a foreign market for a lower price than in the domestic market or for a lower price than its cost of production.

Duopoly A market structure in which two producers of a good or service compete.

Dynamic comparative advantage A comparative advantage that a person or country possesses as a result of having specialized in a particular activity and then, as a result of learning-by-doing, becoming the producer with the lowest opportunity cost.

Economic activity rate The state of the labour market is indicated by this, the employmentto-population ratio and the unemployment rate.

Economic depreciation The decrease in the market price of a piece of capital over a given period.

Economic efficiency A situation that occurs when the cost of producing a given output is as low as possible.

Economic growth The expansion of production possibilities that results from capital accumulation and technological change.

Economic information Data on prices, quantities and qualities of goods and services and factors of production.

Economic model A description of some aspect of the economic world that includes only those features of the world that are needed for the purpose at hand.

Economic profit A firm’s total revenue minus its opportunity cost.

Economic rent The income received by the owner of a factor of production in excess of the amount required to induce that owner to offer the factor for use.

Economic stability The absence of wide fluctuations in the economic growth rate, the level of employment and average prices.

Economic theory A generalization that summarizes what we think we understand about the economic choices that people make and the performance of industries and entire economies.

Economics The study of the choices people make to cope with scarcity.

Economies of scale Technological conditions under which long-run average cost decreases as output increases.

Economies of scope Decreases in average total cost made possible by increasing the range of goods produced.

Economy A mechanism that allocates scarce resources among competing uses.

Efficiency A point in production where it is not possible to produce more of one good without producing less of some other good.

Efficiency wage The wage rate that maximizes profit.

Efficient choice Choice which leads to the production of the most highly valued goods and services and the efficient use of resources.

Efficient market A market in which the actual price embodies all currently available relevant information.

Elastic Where a small percentage change in price results in a proportionately larger change in the quantity demanded.

Elasticity of supply The responsiveness of the quantity supplied of a good to a change in its price, other things remaining the same.

Emission charges Any form of pollution control that uses the market to create incentives for producers to cut pollution emissions.

Emission standards Pollution control in the form of regulations limiting the quantity of pollution emissions.

Employment-to-population ratio The percentage of people of working age who have jobs.

Entrants People who enter the workforce.

Entrepreneurial ability A special type of human resource that organizes the other three factors of production – labour, land and capital – and makes business decisions, innovates and bears business risk.

Environment capital Includes elements of land which are lost forever when used in the production process as well as the degree of biodiversity among species and the ability of the environment to absorb waste from production.

Equal pay for equal worth Where employees are paid the same wage for different jobs considered to be of comparable worth.

Equation of exchange An equation that states that the quantity of money multiplied by the velocity of circulation equals GDP.

Equilibrium price The price at which the quantity demanded equals the quantity supplied.

Equilibrium quantity The quantity bought and sold at the equilibrium price.

Equity In economics, equity has two meanings: economic justice or fairness and the owner’s stake in a business.

Equity withdrawal Borrowing by owner–occupiers from the mortgage issuer against the value of their home without actually moving house.

European Currency Unit (ECU) A composite currency unit made up of the currencies of the member countries of the European Union.

European Monetary System (EMS) The system by which members of the European Union cooperate on monetary matters to achieve exchange rate stability.

European Monetary Union (EMU) A currency union of all participating member countries of the European Union, where a single currency, the Euro, will replace individual country currencies.

Excess reserves A bank’s actual reserves minus its required reserves.

Exchange efficiency A situation in which a good or service is exchanged at a price that equals both the marginal social benefit and the marginal social cost of the good or service.

Exchange Rate Mechanism (ERM) A system of pegged exchange rates among participating currencies. It is a parity grid system where each currency has a set of bilateral central parities and a band by which it is allowed to float.

Excise tax A tax on the sale of a good or service. The tax is paid when the good or service is bought.

Exhaustible natural resources Natural resources that can be used only once and that cannot be replaced once they have been used.

Expansion A business cycle phase in which there is a speedup in the pace of economic activity.

Expansionary fiscal policy An increase in government expenditure or a decrease in tax revenues.

Expected utility The average utility arising from all possible outcomes.

Exports The goods and services that we sell to people in other countries.

External benefits Benefits that accrue to members of the society other than the buyer of the good.

External costs Costs that are borne by members of society other than the producer of the good.

External diseconomies Factors outside the control of a firm that raise the firm’s costs as the industry produces a larger output.

External economies Factors beyond the control of a firm that lower the firm’s costs as the industry produces a larger output.

Externality A cost or a benefit arising from an economic activity that affects people other than those who decide the scale of the activity.

Feedback-rule policy A rule that specifies how policy actions respond to changes in the state of the economy.

Fiat money An intrinsically worthless (or almost worthless) commodity that serves the functions of money.

Financial capital The supply of funds by households to firms for the purchase of capital, either directly through share ownership or indirectly through the financial and banking system.

Financial innovation The development of new financial products – new ways of borrowing and lending.

Financial intermediary An institution that receives deposits and makes loans.

Firm An institution that hires factors of production and that organizes those factors to produce and sell goods and services.

Fiscal policy The government’s attempt to influence the economy by varying its purchases of goods and services and taxes to smooth the fluctuations in aggregate expenditure; use of the government budget to achieve macroeconomic objectives such as full employment, sustained long-term economic growth and price level stability.

Five-firm concentration ratio The percentage of the value of sales accounted for by the largest five firms in one industry.

Fixed cost The cost of a fixed input; a cost that is independent of the output level.

Fixed exchange rate A system in which the value of a country’s currency is pegged by the country’s central bank.

Fixed-rule policy A rule that specifies an action to be pursued independently of the state of the economy.

Flexible exchange rate A system in which the value of a country’s currency is determined by market forces in the absence of central bank intervention.

Flow A quantity per unit of time.

Foreign exchange market The market in which the currency of one country is exchanged for the currency of another.

Foreign exchange rate The price at which one currency exchanges for another.

Free rider A person who consumes a good without paying for it.

Frictional unemployment Unemployment arising from normal labour turnover – new entrants are constantly coming into the labour market, and firms are constantly laying off workers and hiring new workers.

Full employment A situation which occurs when the unemployment rate equals the natural rate of unemployment – when all unemployment is frictional and structural and there is no cyclical unemployment.

Futures market An organized market operated on a futures exchange in which large-scale contracts for the future delivery of goods can be exchanged.

Fundamental economic problem How to use limited resources to produce and consume the most highly valued goods and services.

Game theory A method of analysing strategic behaviour.

GDP deflator A price index that measures the average level of the prices of all goods and services that make up GDP.

General Agreement on Tariffs and Trade An international agreement that limits government intervention to restrict international trade.

Gold standard A monetary system with fractionally backed convertible paper in which a currency could be converted into gold at a guaranteed value on demand.

Government budget Finances the activities of the government.

Government debt The total amount of borrowing that the government has undertaken and the total amount that it owes to households, firms and foreigners.

Government purchases Goods and services bought by the government.

Government purchases multiplier The amount by which a change in government purchases of goods and services is multiplied to determine the change in equilibrium expenditure that it generates.

Great Depression A decade (1929–39) of high unemployment and stagnant production throughout the world economy.

Green tax A form of pollution control where a tax equal to the marginal external cost of pollution is charged on output.

Gresham’s Law The tendency for bad (debased) money to drive good (not debased) money out of circulation.

Gross domestic product (GDP) The value of all final goods and services produced in the economy in a year.

Gross investment The amount spent on replacing depreciated capital and on net additions to the capital stock.

Growth accounting A method of calculating how much real GDP growth has resulted from growth of labour and capital and how much is attributable to technological change.

Hotelling Principle The proposition that the market for the stock of a natural resource is in equilibrium when the price of the resource is expected to rise at a rate equal to the interest rate on similarly risky assets.

Human capital The skill and knowledge of people, arising from their education and on-the-job training.

Hysteresis The idea that the natural rate of unemployment depends on the path of the actual unemployment rate; where the unemployment rate ends up depends on where it has been.

Implicit rental rate The rent that a firm pays to itself for the use of the assets that it owns.

Import function The relationship between imports and real GDP.

Imports The goods and services that we buy from people in other countries.

Incentive An inducement to take a particular action.

Incentive regulation scheme A regulation that gives a firm an incentive to operate efficiently and keep costs under control.

Income effect The change in consumption that results from a change in the consumer’s income, other things remaining the same.

Income elasticity of demand The responsiveness of demand to a change in income, other things remaining the same. It is calculated as the percentage change in the quantity demanded divided by the percentage change in income.

Increasing marginal returns The tendency for the marginal product of a variable factor initially to increase as additional units of the variable factor are employed.

Increasing returns to scale Technological conditions under which a given percentage increase in all the firm’s inputs results in the firm’s output increasing by a larger percentage.

Indifference curve A line that shows combinations of goods among which a consumer is indifferent.

Individual demand The relationship between the quantity of a good or service demanded by a single individual and the price of a good or service.

Induced expenditure The part of aggregate planned expenditure on UK-produced goods and services that varies as real GDP varies.

Induced taxes Taxes that vary as real GDP varies.

Industrial union A group of workers who have a variety of skills and job types but who work for the same firm or industry.

Inelastic Where a small percentage change in price results in a proportionately smaller change in the quantity demanded.

Infant-industry argument The proposition that protection is necessary to enable an infant industry to grow into a mature industry that can compete in world markets.

Inferior good A good for which demand decreases as income increases.

Inflation An upward movement in the average level of prices; a process in which the price level is rising and money is losing value.

Information cost The cost of acquiring information on prices, quantities and qualities of goods and services and factors of production – the opportunity cost of economic information.

Insider–outsider theory A theory of job rationing that says that to be productive, new workers – outsiders – must receive on-the-job training from existing workers – insiders.

Intellectual property rights Property rights for discoveries owned by the creators of knowledge.

Interest rate The amount received by a lender and paid by a borrower expressed as a percentage of the amount of the loan.

Intermediate goods and services Goods and services that are used as inputs into the production process of another good or service.

International Monetary Fund (IMF) An international organization that monitors balance of payments and exchange rate activities.

International substitution effect The substitution of domestic goods and services for foreign goods and services or of foreign goods and services for domestic goods and services.

Intertemporal substitution effect The substitution of goods and services now for goods and services later or of goods and services later for goods and services now.

Inverse relationship A relationship between variables that move in opposite directions.

Investment The purchase of new plant, equipment and buildings and additions to stock.

Investment demand The relationship between the level of planned investment and the real interest rate, all other influences on investment remaining the same.

Isocost line A line showing all possible combinations of two inputs that can be bought for a given total cost.

Isocost map A map of all possible isocost lines, holding the price of inputs constant.

Isoquant A curve showing the possible combinations of two inputs required to produce a given quantity of output.

Isoquant map A map of all possible isoquants.

Job leavers People who voluntarily quit their jobs.

Job losers People who are laid off, either permanently or temporarily, from their jobs.

Job rationing The practice of paying employed people a wage that creates an excess supply of labour and a shortage of jobs, and increases the natural rate of unemployment.

Job search The activity of people looking for acceptable vacant jobs.

Keynesian theory of the business cycle
A theory that regards volatile expectations as the main source of economic fluctuations.

Labour The time and effort that people allocate to producing goods and services.

Labour demand curve A curve that shows the quantity of labour that firms plan to hire at each possible real wage rate.

Labour supply curve A curve that shows the quantity of labour that households plan to supply at each possible real wage rate.

Land All the natural resources used to produce goods and services.

Law of diminishing returns A law stating that as the quantity of one input increases with the quantities of all other inputs remaining the same, output increases but by ever smaller increments.

Learning-by-doing People become more productive in an activity (learn) just by repeatedly producing a particular good or service (doing).

Least-cost technique The combination of inputs to produce a given output that minimizes total cost.

Legal monopoly A market structure in which there is one firm and entry is restricted by the granting of a public franchise, licence, patent or copyright, or the firm has acquired ownership of a significant portion of a key resource.

Limit pricing The practice of charging a price below the monopoly profit-maximizing price and producing a quantity greater than that at which marginal revenue equals marginal cost so as to deter entry.

Limited information and uncertainty A form of market failure caused when the assumption of full information and full knowledge of all future outcomes fails to hold.

Limited resources The land, labour, capital and entrepreneurship used to produce goods and services.

Linear relationship A relationship between two variables that is illustrated by a straight line.

Liquidity The property of being instantly convertible into a means of payment with little loss in value.

Loan market A market in which households and firms make and receive loans.

Long run A period of time in which a firm can vary the quantities of all its inputs.

Long-run aggregate supply curve The relationship between the aggregate quantity of final goods and services (GDP) supplied and the price level (GDP deflator), other things remaining the same and there is full employment.

Long-run cost The cost of production when a firm uses the economically efficient plant size.

Long-run Phillips curve A curve that shows the relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate.

Long-term unemployed People who have remained unemployed for over 12 months.

Lorenz curve A curve that plots the cumulative percentage of income against the cumulative percentage of population.

Lump-sum tax multiplier The amount by which a change in lump-sum taxes is multiplied to determine the change in equilibrium expenditure that it generates.

Lump-sum taxes Taxes that are fixed by the government and do not vary with real GDP.

M0 Consists of currency held by the public, the banks, the building societies and banks’ deposits at the Bank of England. See also Monetary base.

M4 Currency held by the public and all bank and building society sight and time deposits.

Macroeconomic long run A period that is sufficiently long for the prices of all the factors of production to have adjusted to any disturbance.

Macroeconomic short run A period during which the prices of goods and services change in response to changes in demand and supply but the prices of factors of production do not change.

Macroeconomics The study of the national economy and the global economy, the way that economic aggregates grow and fluctuate, and the effects of government actions on them.

Managed exchange rate A system in which the value of a country’s currency is not fixed at some pre-announced level but is influenced by central bank intervention in the foreign exchange market.

Marginal benefit The extra benefit received from a small increase in the consumption of a good or service. It is calculated as the increase in total benefit divided by the increase in consumption.

Marginal cost The change in total cost that results from a unit increase in output. It is calculated as the increase in total cost divided by the increase in output.

Marginal cost pricing rule A rule that sets the price of a good or service equal to the marginal cost of producing it.

Marginal product The extra output produced as a result of a small increase in the variable factor. It is calculated as the increase in total product divided by the increase in the variable factor employed, when the quantities of all other factors are constant.

Marginal propensity to consume The fraction of the last pound of disposable income that is spent on consumption goods and services.

Marginal propensity to import The fraction of the last pound of real GDP spent on imports.

Marginal propensity to save The fraction of the last pound of disposable income that is saved.

Marginal rate of substitution The slope of an isoquant showing how much one input must increase for a given decrease in another input to keep output constant. (The rate at which a person will give up one good or service in order to get more of another good or service and at the same time remain indifferent.)

Marginal revenue The extra total revenue received from selling one additional unit of the good or service. It is calculated as the change in total revenue divided by the change in quantity sold.

Marginal revenue product The extra total revenue received from employing one more unit of a factor of production while the quantity of all other factors remains the same. It is calculated as the increase in total revenue divided by the increase in the quantity of the factor.

Marginal social benefit The marginal benefit received by the producer of a good (marginal private benefit) plus the marginal benefit received by other members of society (external benefit).

Marginal social cost The marginal cost incurred by the producer of a good (marginal private cost) plus the marginal cost imposed on other members of society (external cost).

Marginal utility The change in total utility resulting from a one-unit increase in the quantity of a good consumed.

Marginal utility per pound spent The marginal utility obtained from the last unit of a good consumed divided by the price of the good.

Market Any arrangement that enables buyers and sellers to get information and to do business with each other.

Market activity People undertake market activity when they buy goods and services in goods (or services) markets or sell the services of the factors of production that they own in factor markets.

Market demand The total demand for a good or service by everyone in the population. It is illustrated by the market demand curve.

Market failure The failure of an unregulated market to achieve an efficient allocation of resources.

Market socialism An economic system that combines state ownership of capital and land with incentives based on a mixture of market prices and laws and regulations.

Maximize total utility A major assumption of marginal utility theory which implies that individuals choose as if they made the marginal utility per pound spent on each good equal.

Means of payment A method of settling a debt.

Median voter theorem The proposition that political parties will pursue policies that appeal most to the median voter.

Merger The combining of the assets of two firms to form a single, new firm.

Microeconomics The study of the decisions of people and businesses, the interactions of those decisions in markets, and the effects of government regulation and taxes on the prices and quantities of goods and services.

Minimum wage The wage below which it is illegal to employ someone under minimum wage law.

Minimum wage law A regulation that prohibits labour services being paid at less than a specified wage rate.

Monetarist theory of the business cycle
A theory that regards fluctuations in the money stock as the main source of economic fluctuations.

Monetary base The sum of the notes and coins in circulation and banks’ deposits at the Central Bank. See also M0.

Monetary policy The government’s attempt to achieve macroeconomic objectives by adjusting the quantity of money in circulation and interest rates.

Money Any commodity or token that is generally acceptable as a means of payment for goods and services.

Money multiplier The amount by which a change in the monetary base is multiplied to determine the resulting change in the quantity of money.

Monopolistic competition A market structure in which a large number of firms compete with each other by making similar but slightly different products.

Monopoly An industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.

Monopoly control law A law that defines and regulates practices which lead to the monopoly structure and monopoly power in industry.

Monopoly power The ability to exercise the power of a monopoly to raise price by restricting output.

Monopsony A market structure in which there is just a single buyer.

Moral hazard A situation in which one of the parties to an agreement has an incentive, after the agreement is made, to act in a manner that brings additional benefits to himself or herself at the expense of the other party.

Multiplier The change in equilibrium real GDP divided by the change in autonomous expenditure.

Nash equilibrium The outcome of a game that occurs when player A takes the best possible action given the action of player B, and player B takes the best possible action given the action of player A.

Oligopoly A market structure in which a small number of producers compete with each other.

Open market operation The purchase or sale of government securities by the Bank of England designed to influence the money supply.

Opportunity cost The opportunity cost of an action is the best forgone alternative.

Pareto efficiency Another term for allocative efficiency where the market could not reallocate resources through trade, production or consumption to make at least one person better off without making anybody else worse off.

Patent A government-sanctioned exclusive right granted to the inventor of a good, service, or productive process to produce, use and sell the invention for a given number of years.

Payment system The generally accepted method of payment for trade in an economy.

Payoff matrix A table that shows the payoffs for every possible action by each player for every possible action by each other player.

Perfect competition A market structure in which there are many firms; each firm sells an identical product; there are many buyers; there are no restrictions on entry into the industry; firms in the industry have no advantage over potential new entrants; and firms and buyers are completely informed about the price of each firm’s product.

Perfectly elastic demand Demand with an infinite price elasticity; the quantity demanded is infinitely responsive to a change in price.

Perfectly inelastic demand Demand with a price elasticity of zero; the quantity demanded remains constant when the price changes.

Phillips curve A curve that shows a relationship between inflation and unemployment.

Political equilibrium A situation in which the choices of voters, politicians and bureaucrats are all compatible and in which no one group can improve its position by making a different choice.

Poor definition of property rights A form of market failure where the legal rights to property are not clearly defined.

Positive relationship A relationship between two variables that move in the same direction.

Potential GDP A situation in which all the economy’s labour, capital, land and entrepreneurial ability are fully employed.

Poverty A state in which a family’s income is too low to be able to buy the quantities of food, shelter and clothing that are deemed necessary.

Preferences A person’s likes and dislikes for goods and services which are described by the economist’s measure of utility.

Present value The amount of money that, if invested today, will grow to be as large as a given future amount when the interest that it will earn is taken into account.

Price ceiling A regulation that makes it illegal to charge a price higher than a specified level.

Price discrimination The practice of charging some customers a lower price than others for an identical good or of charging an individual customer a lower price per unit on a large purchase than on a small one, even though the cost of servicing all customers is the same.

Price effect The change in consumption that results from a change in the price of a good or service, other things remaining the same.

Price elasticity of demand The responsiveness of the quantity demanded of a good to a change in the price of a good or service, other things remaining the same.

Price level The average level of prices as measured by a price index.

Price taker A firm that cannot influence the price of the good or service it produces.

Principal–agent problem A form of market failure arising in a contractual relationship when one party, the principal, cannot fully monitor the activities of the other party, the agent.

Private information Information that is available to one person but is too costly for anyone else to obtain.

Private sector surplus or deficit The difference between saving and investment.

Privatization The process of selling a public company or public sector assets to private shareholders.

Producer efficiency A situation in which it is not possible to produce more of one good without producing less of some other good.

Producer surplus The price a producer gets for a good or service minus the opportunity cost of producing it.

Product differentiation Making a good or service slightly different from that of a competing firm.

Production efficiency The level of production when no more of one good can be produced without producing less of some other good.

Production function The relationship that shows how the maximum output attainable varies as quantities of all inputs vary.

Production possibility frontier The boundary between those combinations of goods and services that can be produced and those that cannot.

Productivity The amount of output produced per unit of inputs used to produce it.

Productivity function A relationship that shows how real GDP per hour of labour changes as the amount of capital per hour of labour changes with no change in technology.

Productivity growth slowdown A slowdown in the growth rate of output per person.

Progressive income tax A tax on income at a marginal rate that increases with the level of income.

Property rights Social arrangements that govern the ownership, use and disposal of factors of production and goods and services.

Proportional income tax A tax on income that remains at a constant rate, regardless of the level of income.

Protectionism The restriction of international trade.

Public choice theory A theory predicting the behaviour of the government sector of the economy as the outcome of the individual choices made by voters, politicians and bureaucrats interacting in a political marketplace.

Public good A good or service that can be consumed simultaneously by everyone and from which no one can be excluded.

Public interest theory A theory of regulation that states that regulations are supplied to satisfy the demand of consumers and producers to maximize total surplus – that is, to attain allocative efficiency.

Public ownership Ownership of corporations by government rather than private shareholders.

Public Sector Borrowing Requirement (PSBR) The budget deficit of the government and public corporations.

Public Sector Debt Repayment (PDSR) The budget surplus of the government and public corporations.

Quantity demanded The amount of a good or service that consumers plan to buy during a given time period at a particular price.

Quantity of sterling assets The net stock of financial assets denominated in pounds sterling held outside the Bank of England and the government.

Quantity supplied The amount of a good or service that producers plan to sell during a given time period at a particular price.

Quantity theory of money The proposition that in the long run, an increase in the quantity of money brings an equal percentage increase in the price level.

Quota A restriction on the quantity of a good that a firm is permitted to produce or that a country is permitted to import.

Rate of return regulation A regulation that determines a regulated price by setting the price at a level that enables the regulated firm to earn a specified target percentage return on its capital.

Rate of time preference The target real interest rate that savers want to achieve.

Rational expectation A forecast based on all available relevant information.

Rational ignorance The decision not to acquire information because the cost of doing so exceeds the expected benefit.

Real business cycle theory A theory that regards random fluctuations in productivity that result from technological change as the main source of economic fluctuations.

Real exchange rate An index number that gives the opportunity cost of foreign-produced goods and services in terms of UK-produced goods and services.

Real GDP per person Real GDP divided by the population.

Real gross domestic product (real GDP)
The output of final goods and services valued at prices prevailing in the base period.

Real income The quantity of a good that a consumer’s income will buy. It is the consumer’s income expressed in units of a good and is calculated as income divided by the price of the good.

Real interest rate The interest rate paid by a borrower and received by a lender after taking into account the change in the value of money resulting from inflation; the nominal interest rate minus the inflation rate.

Real money A measure of money based on the quantity of goods and services it will buy.

Real money balances effect

Real price A relative price where the money price of a good is divided by the price of a representative basket of goods.

Real wage rate The wage rate per hour expressed in constant pounds.

Recession A downturn in the level of economic activity in which real GDP falls in two successive quarters.

Regressive income tax A tax on income at a marginal rate that decreases with the level of income.

Regulation Rules enforced by a government agency to restrict or control economic activity in price setting, product standards, trading standards and the conditions under which firms can enter an industry.

Relative price The ratio of the price of one good or service to the price of another good or service. A relative price is an opportunity cost.

Rent ceiling A regulation that makes it illegal to charge a rent higher than a specified level.

Rent seeking The activity of searching out or creating a monopoly from which an economic profit can be made.

Required reserve ratio The ratio of reserves to deposits that banks are required, by regulation, to hold.

Reservation price The highest price that a buyer is willing to pay for a good.

Reservation wage The lowest wage rate for which a person will supply labour to the market. Below that wage, the person will not supply labour.

Reserve ratio The fraction of a bank’s total deposits that are held in reserves.

Reserves Cash in a bank’s vault plus the bank’s deposits at the Bank of England.

Restrictive practice An agreement between two firms not to compete in some respect such as price, output levels or quality.

Retail Prices Index (RPI) An index of the prices of a basket of goods purchased by a typical UK family.

Returns to scale The increase in output that results when a firm increases all its inputs by the same percentage.

Risk A situation in which more than one outcome might occur and the probability of each possible outcome can be estimated.

Saving Income minus consumption. Saving is measured in the national income accounts as disposable income (income less taxes) minus consumption expenditure.

Saving function The relationship between saving and disposable income, other things remaining the same.

Saving supply The relationship between saving and the real interest rate, other things remaining the same.

Savings bank A financial intermediary owned by its depositors that accepts deposits and makes loans, mostly for consumer mortgages.

Scarcity The universal state in which wants exceed resources.

Scatter diagram A diagram that plots the value of one economic variable against the value of another.

Search activity The time spent in looking for someone with whom to do business.

Shares Long-term assets issued by firms which can be traded in stock markets.

Short run The short run in microeconomics has two meanings. For the firm, it is the period of time in which the quantity of at least one of its inputs is fixed and the quantities of the other inputs can be varied. The fixed input is usually capital – that is, the firm has a given plant size. For the industry, the short run is the period of time in which each firm has a given plant size and the number of firms in the industry is fixed.

Short-run aggregate supply curve A curve showing the relationship between the quantity of real GDP supplied and the price level, other things remaining the same.

Short-run industry supply curve A curve that shows how the quantity supplied by the industry varies as the market price varies when the plant size of each firm and the number of firms in the industry remain the same.

Short-run macroeconomic equilibrium A situation that occurs when the quantity of real GDP demanded equals the short-run quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve.

Short-run Phillips curve A curve showing the relationship between inflation and unemployment, when the expected inflation rate and the natural rate of unemployment remain the same.

Shutdown point The price and output level at which the firm just covers its total variable cost. In the short run, the firm is indifferent between producing the profit-maximizing output and shutting down temporarily. If it produces, it makes a loss equal to its total fixed cost.

Signal An action taken outside a market that conveys information that can be used by that market.

Slope The change in the value of the variable measured on the y-axis divided by the change in the value of the variable measured on the x-axis.

Socialism An economic system with state ownership of capital and land and incentives based on laws and regulations.

Stagflation The combination of a rise in the price level and a fall in real GDP.

Stock A quantity measured at a point in time.

Stock market A market in which the shares of corporations are traded.

Strategies All the possible actions of each player in a game.

Structural deficit A budget that is in deficit even though real GDP equals potential GDP; expenditures are high relative to tax revenues over the entire business cycle.

Structural unemployment The unemployment that arises when there is a decline in the number of jobs available in a particular region or industry.

Subsidy A payment made by the government to producers that depends on the level of output.

Substitution effect The effect of a change in price of one good or service on a consumer’s consumption of goods and services when the consumer remains indifferent between the original and the new consumption bundles – that is, the consumer remains on the same indifference curve.

Supply The relationship between the quantity of a good that producers plan to sell and the price of the good, with all other influences on sellers’ plans remaining the same. It is described by a supply schedule and illustrated by a supply curve.

Supply curve A curve that shows the relationship between the quantity supplied and the price of a good, all other influences on producers’ planned sales remaining the same.

Takeover The purchase of the stock of one firm by another firm.

Tariff A tax on an import by the government of the importing country.

Technological efficiency A situation that occurs when it is not possible to increase output without increasing inputs.

Technological progress The development of new and better ways of producing goods and services and the development of new goods.

Time series graph A line graph of one or more economic variables plotted over time.

Total cost The sum of the costs of all the inputs a firm uses in production.

Total fixed cost The total cost of the fixed inputs.

Total product The total output produced by a firm in a given period of time.

Total revenue The value of a firm’s sales. It is calculated as the price of the good multiplied by the quantity sold.

Total surplus The sum of consumer surplus and producer surplus.

Total utility The total benefit or satisfaction that a person gets from the consumption of goods and services.

Total variable cost The total cost of the variable inputs.

Trade-off A constraint that entails giving up one thing to get something else.

Trade union A group of workers organized principally for the purpose of increasing wages and improving conditions.

Trade-weighted index The value of a basket of currencies in which the weight placed on each currency is related to its importance in UK international trade.

Transactions costs The costs incurred in searching for someone with whom to do business, in reaching an agreement about the price and other aspects of the exchange, and in ensuring that the terms of the agreement are fulfilled.

Transfer earnings The income that an owner of a factor of production requires to induce the owner to supply the factor.

Trend A general direction (rising or falling) in which a variable is moving over the long term.